Wednesday, April 25, 2012

CPI weak. Why the Bank will cut, then cut again

Australia is in for a new round of rate cuts, beginning with a cut of at least 0.25 points at the Reserve Bank board meeting next Tuesday followed by extra cuts to boost the economy in the wake of a contractionary May budget.

Debate at Tuesday’s meeting will be about whether to cut the cash rate 0.25 or 0.50 points after much weaker than expected inflation figures showed very little price pressure in the economy away from utilities and services such as childcare and health.

The consumer price index climbed just 0.1 per cent in the first three months of year, and by just 1.6 per cent over the year to March - the weakest annual price growth since the 2009 global financial crisis.

Weighing down prices was a 60 per cent drop in the price of bananas in the quarter and a 30 per cent side in the price of fruit. Over the year to March fruit prices fell 24 per cent and vegetable prices 17 per cent.

Even ignoring the price of volatile items such as fruit and vegetables inflation is weak. The Reserve Bank’s measure of so-called underlying inflation came in at an extraordinarily low 0.35 per cent for the quarter and 2.15 per cent for the year. The annual figure is the lowest in 13 years.

“The Reserve Bank got it wrong,” said Stephen Koukoulas, an economic consultant who was until recently an advisor to prime minister Gillard. “They should have cut in February, they should have cut in April. Even as late as last year they were expecting inflation above 3 per cent. It is now clear they underestimated the impact of the strong dollar and failed to appreciate how weak retailing and construction really were.

“This is not a harsh criticism. Every error the Reserve Bank has made in the past it has corrected. There is nothing embarrassing about reversing course. The Bank will cut by at least 0.25 points Tuesday and possibly 0.50 points. I think they should cut by 0.50 to offset some of some of the rate hikes imposed by retail banks"...

Treasurer Wayne Swan said while the Reserve Bank was independent “you would only have to look at their minutes published a week or two ago to see that they themselves have said that they'll be looking closely at this inflation number, and they will do that and take their decision independently”.

The Bank said if inflation eased further “a case could be made for a further easing of monetary policy”.

The recommendation to be sent to board members this week will be for a rate cut. Governor Glenn Stevens will open the meeting up for discussion about the size of the cut. Further cuts will be needed if private banks fail to pass on all of the cuts or if the May Budget dampens the economy as is expected.

Financial markets were last night pricing in four more cuts of 0.25 per cent by Melbourne Cup day, taking the Reserve Bank cash rate down from 4.25 per cent to 3.25 per cent. If fully passed on they would bring down standard variable mortgage rates from around 7.4 per cent to 6.4 per cent, cutting $190 per month from the cost of servicing a $300,000 mortgage taking the monthly total below $2000.

Attempts to make political capital of the Reserve Bank’s deliberations turned to farce yesterday when opposition leader Tony Abbott wondered out loud whether the Bank would “lover interest rates today”, apparently unaware the Bank board wasn’t meeting until next Tuesday. Financial services minister Bill Shorten pounced, saying anyone who wanted to be the alternative prime minister ought to know when the Bank board met.

“The Reserve Bank board has been meeting on the second Tuesday of the month since 1960,” he told the ABC’s PM program. Mr Shorten was also wrong. The board meets on the first Tuesday of the month.

The inflation figures show prices for necessities increasing strongly. Electricity prices climbed 9.9 per cent during the year, childcare prices 9.7 per cent and petrol prices 5.9 per cent. The price slides were more likely to be in optional purchases. International travel was down in price 3.1 per cent, women’s clothes 2.8 per cent, computers and electronics 9.7 per cent and CDs, DVDs and computer software 18 per cent.

In today's Sydney Morning Herald and Age

COLEBATCH: "The Reserve made a mess of it. It kept overestimating growth. It kept overestimating inflation. It raised interest rates far too high, and has kept them too high. It has no more excuses. It must now fix the problems it created."


Electricity + 9.9%
Childcare + 9.7%
Water and sewerage + 9.3%
Insurance + 7.3%
Tobacco + 6.3%
Public transport + 6.2%
Education + 6%
Medical & dental + 5.9%
Petrol + 5.9%
Domestic travel + 5.4%
Telecommunications + 4.5%
Rents + 4.4%
Beer + 3.4%

Men’s clothes - 1.4%
Women’s clothes - 2.8%
Motor vehicles - 2.8%
Milk - 4%
International travel - 3.1%
Computers and electronics - 9.7%
Vegetables - 17.1%
CDs, DVDs and software - 18%
Fruit - 24%

ABS 6401.0 Consumer prices, year to March

Related Posts

. Inflation is not what it was - that's official

. Attention Reserve Bank: Inflation is not as bad as it looks

. At last, the RBA gets off its hands. Why it's May 1